Vendor loan notes in business valuations

We go over what vendor loan notes are why they are important for bridging valuation gaps in mergers and acquisitions.

What is a Vendor Loan Note and what are they for?

When a buyer is looking to acquire a business, there may be a gap in how much they are willing to pay and the vendor’s valuation of their own business. To bridge this gap, vendors may agree to a written contract (a note) to cover the shortfall in value with a deferred loan to the buyer.

That’s why this process is sometimes called “vendor financing”. To ensure the acquisition goes through, the buyer agrees to take on the difference between their buying price and the company’s value as debt. This is crucial to take into account when determining a business’ true value.

Vendor loan notes issued to parties other than regular banks will often have non-standard terms. As such, they can have a big effect on the future sale or merging of the company if the debt is still outstanding.

Further down we’ll go into how vendor loan notes should be considered in a business valuation. If you’re looking to talk to an expert on this topic, you can contact one of our agents here or by calling us on 01223 728222.

So how should they be treated in a business valuation?

Loan notes could be considered positive if they represent “soft funding”, i.e. as a form of subsidy or financial support on behalf of the seller. But it is more complicated than that.

When evaluating whether the notes are positive or negative, a valuator may ask questions like: Are there provisions to roll up interest? Is there a significant redemption premium?

Either could cause business failure in the long term if they’re allowed to build up. This is what we’d consider a negative impact from a vendor loan note.

And at any rate, vendor loan notes need proper consideration in any cash flow calculation used in a business valuation. In the case of mergers and acquisitions, buyers will have to take the debt into account, while sellers may treat the debt as part of the total consideration.

How to manage your loan as a vendor

If you have sold or are looking to sell a business using a vendor loan note as compensation for an acquisition shortfall, here are some of the things you’ll want to keep in mind:

• Structure your loan: Terms on interest rates, repayment schedules, security and so on must be transparent and unambiguous from the outset.
• Secure your loan: Ensure your loan is secured over business assets, shares or personal guarantees to mitigate risk. 
• Monitor buyer performance: Reviewing management accounts, cash flow and other aspects of the business to identify early signs of repayment risk.
• Prepare for renegotiation: Be ready to renegotiate the terms of the loan agreement if circumstances change, ensuring you have appropriate legal support.

The main responsibilities of a loan holder are to ensure the loan can be repaid in a way that is good for the future of the company, especially if your loan is secured against shares in said company.

At PEM we take pride in helping clients keep on top of their business dealings. If you’re looking for help with drafting terms for a vendor loan note or any other corporate or financial assistance, contact our experts here or call us on 01223 728222 today.